SEBI Tightens Rules For Fundraising Through IPO And Preferential Issue Amidst 2022, IPO Rush.

Several renowned Indian startups, including Paytm, Zomato, and Policybazaar, obtained funding via initial public offerings ("IPOs") on the Indian stock exchange in 2021. Zomato's record-breaking IPO in July 2021 was a landmark moment for India's stock markets and startup ecosystem. Nykaa, Paytm, and Policybazaar were among the companies that followed Zomato.

Around $1 trillion worth of funds have been raised via IPOs in India alone previous year.

In 2022, the IPO frenzy will continue. This year, approximately 16 startups are likely to go public. Hospitality unicorn OYO, logistics behemoth Delhivery, and mobility unicorn Ola are among the startup ecosystem's giants set to go public in 2022. Life Insurance Company of India, Adani Wilmar, Byju's, Mobikwik Credit Private Limited are also scheduled for 2022. The boom in capital markets is evidently exponential.

The Securities and Exchange Board of India (SEBI), the governing institution in the regulatory regime under the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (ICDR Regulations), in a public statement on December 28 2021, made new amendments in light of the rapidly growing IPO marketplace and to ensure financial stability. These amendments come at a time when several new-age enterprises are seeking to raise funds via IPO's.

SEBI, the capital and commodity industry supervisor, recently revised the regulations for IPOs, impacting both investors and issuing Companies. The regulator also changed the regulations governing preferential allotment of shares.

Need For New Amendment

Plenty of the companies which obtained capital via IPOs last year, such as Zomato, Paytm, and others are operating at a loss. Investors who have already placed money into IPOs were at the threat of losing a lot of money if the value of these shares fell sharply. Paytm, for example, has suffered a loss of over one-third of its original value ever since its initial public offering. According to SEBI, the new amendments would guarantee that company promoters have more foot in the businesses.

On the other hand, it's pricing band guideline intents to combat the inclination among companies to establish a restricted price band for its issues. A narrow price band, according to SEBI, disrupts the price discovery process.

Analysis

Conditions For Objects Of Issue

If the issuing Company lays out an objective for future inorganic growth in its offer letter but has not specified an acquisition or financing target, then the amount for a general corporate purpose ("GCP") must not surpass thirty-five per cent of the entire amount raised via the IPO. Where the issuing Company has not specified the acquisition target in the draft offer document or the offer letter, the sum allocated for these objectives must not surpass twenty-five per cent of the total sum being collected by the issuer.

These restrictions, however, need not apply if the targeted acquisition or financing investment objective has been specified and appropriate explicit declarations regarding such acquisitions or financing have been provided in the draft offer document and the offer document.

SEBI, seeing the companies' dynamic practices in the market, proposed this Amendment. The provision enforces a Company planning an IPO to disclose per cent of the total amount received that will be used for acquisitions or regular financings. Furthermore, the Amendments impose a limit on the acquisition of unspecified objectives and sums for GCP in the future. This may cause Companies to be more cautious in terms of the amount they seek to raise and with a definitive purpose to raise it.

Conditions For Offer For Sale (OFS)

Shares listed for sales by selling shareholders who possess a total of twenty per cent and above of the issuing Companies pre-issue shareholding but less than fifty per cent of the issuing Companies pre-issue shareholding must not surpass fifty per cent of existing pre-issue shareholding.

Shares listed for sales by selling shareholders who control just under twenty per cent of the issuing Companies pre-issue shareholding must not surpass ten per cent of the issuer's pre-issue shareholding.

This will have an influence on Private Equity, Venture Capitals, and other stakeholders' withdrawal methods, as the extent of their withdrawal would be constrained. As a result, it is essential to gauge if this kind of Amendment is required, as majority IPOs are driven by the ambition of certain investors to quit the issuing firm.

Monitoring Agency And Reporting On Utilisation Of Issue Proceeds:

Instead of Scheduled Commercial Banks (SCBs) and Public Financial Institutions, Credit Rating Agencies (CRAs) affiliated by the Board would be allowed to operate as Monitoring Agencies. Rather than the current ninety-five per cent utilisation of issuance funds, such monitoring will be continued until a hundred per cent utilisation is achieved.

The fund raised for General Corporate Purposes (GCP) will be monitored, and the usage of that fund will be documented in the monitoring agency's report. Rather than "on a yearly basis," the monitoring agency report will be presented to the audit committee "on a quarterly basis."

Rating agencies were not monitoring funds obtained via IPOs before the Amendment was made. Under the amendments, rating agencies will be able to track the deployment of IPO funds until all of them have been utilised. This change will most effectively bar Companies from exploiting IPO funding. Nonetheless, it is unclear in what manner this regulation is to be implemented, with several industry analysts predicting that it would make little influence and will contribute to the complexity of compliance.

Price Band:

SEBI also resolved to establish a minimum price band of 5% for the books build issuance, that employs the price discovery mechanism to generate and monitor investor's desire for share prior to determining the issue price. That means the price gap across the lower and upper pricing bands shall be at minimum five percent.

Previously, Companies planning an IPO were allowed to select their own price band. However according to this change, the higher price band would have to be at least 105 per cent of the lower price band. The Amendment is designed to assure that Companies value their Initial Public Offerings more fairly and appropriately allowing retail investors to be protected.

Lock-In For Anchor Investors

Anchor investors' lock-in period under the Amendment extended from thirty to ninety days, effective after April 2022, and will apply to fifty percent of their total allotment, where the other fifty percent subjected to a thirty day lock-in period. The anchor investors are big investors who are encouraged to purchase shares in a business prior to its initial public offering (IPO) in order to increase the issue's reputation. This amendment is intended to enrich and reassure other investors.

The non-genuine anchor investors would be impacted by the amendment where the lock-in term period has been increased from thirty to ninety days, because they will be forced to re-consider when purchasing the shares only either to endorse the issue or to withdraw their stake once the 30-day lock-in term expires.

Revised Allocation Methodology For Non-Institutional Investors (NIIs)

SEBI has bifurcated non-institutional investor ("NII") allocations, requiring that one third of the portion available to NIIs be reserved for NIIs with application sizes between two lakh rupees and ten lakh rupees, and two thirds of the portion available to NIIs be reserved for NIIs with application sizes greater than ten lakh rupees.

SEBI has also ordered that allotment in the NII category be done through a 'draw of lots,' similar to how it is done now for individual retail investors (i.e. draw of lots to allot minimum application size to applicants, in case of over-subscription and balance allotment on a proportionate basis). This new change was not addressed in the Public Offer Consultation Paper earlier. This bifurcation must be followed for all book built issues beginning or after April 1, 2022.

This was necessary to develop a sub-category for individual investors who are no longer small investors but do not quite fit the description of a High Net-worth Individual (HNI). HNIs who bid with their own money were historically at a disadvantage to HNIs who borrowed significantly and placed high bids. When an issue was heavily subscribed, individuals who placed the most bids had a better chance of receiving it. However, it will not entirely level the playing field, but it will lessen the advantage that the big HNIs currently have due to their ability to borrow extensively and bid.

Floor Price Determination

For all preferential issues, SEBI has lowered the look back period for setting the floor price. The look back time for frequently traded securities has been decreased from 26 weeks/2 weeks to 90 days/10 days, or as per any tighter provision in the issuer company's Articles of Association.

SEBI has now mandated that the floor price be supported by a valuation report from a registered independent valuer for infrequently traded securities and transactions involving a change in control or allotment of more than 5% of the issuer company's post-issue diluted share capital to an allottee or to allottees acting in concert. A committee of independent directors will also be obliged to provide a rationale and recommendation on all aspects of preferential issuance, including pricing, in the event of a change in control. Likewise, the committee's voting pattern will be made available to shareholders and the general public.

Since the previous norm of 26 weeks is a relatively long period for evaluating price in light of market volatility, the periods have been lowered.

The valuation report intends to ensure that minority shareholders are not shortchanged. PNB Housing Finance recently attempted to sell a majority position to Carlyle, a private equity firm, at a price that was considered unfair to PNB Housing Finance's minority shareholders. As a result, companies will be forced to price preferential allotments fairly.

Lock-In Provisions For Preferential Issue

SEBI has attempted to harmonise the lock-in requirements after a preferential allotment with the recent revisions for public issues. The lock-in period for shares issued under a preferential offering will be decreased as follows:

i. In the case of Promoters:

The current three-year lock-in period for allotment of up to 20% of the post-issue share capital would be lowered to eighteen months. The current one-year lock-in period for allotments exceeding 20% of the post-issue share capital will be lowered to six months.

ii. In the case of non-promoters:

The minimum lock-in period for allotments will be shortened from one year to six months.

The three-year lock-in was quite onerous and burdensome for a company that had been listed on the stock exchange platform for a respectable number of years and whose promoters had remained to hold on to their stake during these years. In addition, lock-in requirements for preferential issues needed to be rationalised and harmonised with lock-in provisions for public issues. As a result, this Amendment is a positive step because it will allow promoters and non-promoters to sell their shares in the issuer company in a shorter period of time, allowing for a quicker exit.

Pledging Of Shares

Promoters/promoters' groups would be permitted to pledge shares locked-in pursuant to a preferential issue if the pledge of such specified securities is one of the terms of sanction of a loan granted by certain financial institutions, and the loan is to be sanctioned to the issuer company or its subsidiary(ies) for the purpose of financing one or more of the preferential issue's objects.

Previously, the regulatory framework prevented promoters/promoters groups from pledging of shares allotted to them under a preferential issue during the lock-in period for the purpose of financing the preferential issue's objects. As a result of this Amendment, leeway on shares locked-in under preferential issuance is granted, bringing it in line with public issues as already provided under ICDR Regulation no. 21.

Will The New Norms Help?

SEBI's new rules have been largely praised for attempting to shield retail investors from the hazards associated with the expanding IPO industry. Some worry, however, that the new laws may make it more difficult for businesses to raise new capital to fuel growth.

For example, requiring companies to be detailed about how they would use the money raised through IPOs can limit flexibility, considering how quickly business conditions change in the real world. Furthermore, the anchor investor restriction may hinder market liquidity because many large investors may not be willing to retain their investments over 90 days and hence opt-out of IPOs entirely.

Some critics also question whether SEBI should strive to assist investors in making investment decisions at all. They feel that investors, who stand to lose or gain the most from their investments, are best suited to do the essential due diligence prior to participating in IPOs. The same may be said for how companies price their IPOs. Companies typically avoid underpricing or overpricing their issues since it affects the amount of capital they may raise. Setting narrow price bands, in fact, could be a method to eliminate valuation uncertainty, which can stymie fundraising.

The Amendment Regulations' changes to the existing preferential issue guidelines under the ICDR Regulations are mixed, allowing for certain flexibility while restricting others. The legal battles that have engulfed the country in recent months have brought to light some existing loopholes in the regulations, and the Amendment Regulations seek to close those gaps.

The amendments demonstrate SEBI's desire to protect investors and strengthen disclosure and monitoring standards, and they are a good step forward in India's IPO market development. It makes it easier for the Company to raise funds by easing the conditions of lock-in and pledge of securities under a preferential issue. These developments, however, may offer certain obstacles and have an impact on issuers' ambitions to raise funds through an IPO or preferential issue. In addition, issuers will need to be alert and cautious in order to verify that these Amendments are followed.

Views are personal.